Public Information Notice No. 99/91

Public Information Notice: IMF Concludes Article IV Consultation with Kiribati

September 22, 1999

On July 16, 1999, the Executive Board concluded the Article IV consultation with Kiribati¹.

Background

Real GDP growth picked up from low rates in the early 1990s to average 4½ percent in the past four years, reflecting a temporary boost from increased government spending. Public investment and the civil service wage bill were increased sharply in the mid-1990s, financed initially by unsustainably large drawdowns from the country's trust fund (the Revenue Equalization Reserve Fund (RERF)) and more recently from a favorable revenue shock (due to a sharp increase in the fish catch by foreign vessels) and higher external grants. The Asian crisis had little direct impact on the economy.

Inflation, which has been low, picked up moderately to almost 5 percent in 1998, reflecting import supply problems due to the breakdown of the crane at the main port and the depreciation of the Australian dollar (which is the legal tender), with Kiribati's nominal effective exchange rate index falling 10 percent in 1998.

The budget balance improved from an overall deficit of more than 35 percent of GDP in 1996 to a surplus of 24 percent of GDP in 1998, despite a lack of progress in reducing expenditure. The sharp swing was due to a jump in fishing license revenue to almost 60 percent of GDP (double normal levels) in the wake of strong El Niño climatic conditions that boosted the catch in Kiribati waters. No drawdowns from the RERF were needed in 1998, and reserves in the Consolidated and Development Funds rose.² Current expenditure, however, remained very high at more than 70 percent of GDP.

The jump in fishing license revenue also contributed to an improvement in the external position, with the current account deficit (excluding grants) narrowing sharply to 3 percent of GDP in 1998. The decline in the current account deficit, together with external grants, led to a sizable overall surplus and a rise in official external assets. Valuation gains in the RERF (from the rise in world bond and equity prices and the depreciation of the Australian dollar) also contributed to an increase in external assets to the equivalent of more than 8 times GDP at the end of last year. Public external debt remained low, and was on highly concessional terms (with no short-term debt).³

The depreciation of the Australian dollar since mid-1997 has improved external competitiveness. Kiribati's real effective exchange rate index (based on relative consumer price indices) in March 1999 had fallen to 10 percent below the average for 1994-97, but this fall has offset only part of the estimated increase in private sector labor costs that followed the 30 percent rise in civil service wage rates in the mid-1990s. Nonetheless, labor costs do not influence the major items in the balance of payments (i.e., fishing license fees, external grants, and investment income).

Recent Policy Developments

The key policy development in recent years was the government's adoption of a Medium-Term Strategy in 1997, which focuses on the need to reduce the role of the public sector in order to promote the development of a dynamic private sector, but only limited progress has been made in its implementation. An important slippage was the failure to implement the planned freeze on civil service recruitment, with the number of civil servants increasing by 2 percent in 1998 and budgeted to increase by a further 3 percent in 1999. As a result, the level of recurrent government spending remains high (at 71½ percent of GDP or 42½ percent of GNP in 1999).⁴ In other areas, some reform measures have been taken. Importantly, a decision has been made to improve the accountability of public enterprises (by requiring better reporting of their performance and the preparation of strategic plans before budgetary support is provided), but few enterprises have begun to operate on acommercial basis and there has been no privatization. In addition, some progress has been made toward clarifying land titles. The government's review of the Medium-Term Strategy in February 1999 acknowledged the slow progress and highlighted the need for further action to implement the strategy fully.

Outlook for 1999

The near-term outlook is for relatively slow growth and a fall in revenue from fishing licenses (reflecting a reversal of climatic conditions) which will cause the budget and external current account balances to return to sizable deficits (more than 30 percent and 20 percent of GDP, respectively). Economic activity will be supported by the commencement of an Asian Development Bank (AsDB) water and sanitation project, while inflation is expected to fall to 2 percent in 1999, broadly in line with trading partners.

Executive Board Assessment

The Executive Directors welcomed Kiribati's success in maintaining low inflation and building external assets. While Directors noted that the activist fiscal policy undertaken in the mid-1990s had given a temporary boost to growth, they considered, nevertheless, that the emphasis should be placed on promoting the expansion of private sector activity, which would be assisted by a scaling back of the role of the public sector and a full implementation of the authorities' medium-term strategy, in order to achieve a sustained increase in living standards. They attached great importance to building a broader social consensus for reform.

Directors considered that the authorities' strategy of scaling back the role of the public sector would be facilitated by fiscal consolidation. They recommended the authorities to reduce government expenditure to a sustainable level. Directors also recommended an improvement in the composition of expenditures, to allow increased outlays on the authorities' priority areas of health, education, social welfare, and environmental protection. Directors commended the authorities for their prudent management of the Revenue Equalization Reserve Fund, which underpins the long-term welfare of the i-Kiribati. While this has been built up to an outstanding level, most Directors expressed some concern about the level of current draw downs to finance the budget, although all noted that it was difficult to judge the appropriate rate of draw down.

On structural reforms, Directors considered that public enterprise reform and a downsizing of the civil service should take top priority. They noted that the poor performance of most public enterprises not only burdens the budget but also adversely affects economic efficiency, and they called for an improvement in their performance, including through privatization and greater competition. Directors also underscored the need for civil service reform and to reduce government expenditure and release skilled workers to the private sector. They recognized that this should be pursued without creating undue open unemployment which could be protracted unless employment in the small private sector expands sufficiently to absorb labour released from the public sector

In this regard, Directors agreed that a reduction in barriers to trade and investment, along with reforms in the financial sector, would help to encourage private sector activity and broaden the export base. They also saw the need for further progress on clarifying land titles, improving infrastructure and simplifying procedures for foreign direct investment. Directors also recommended steps to improve public enterprise management and modernize the plantation sector, including with the participation of foreign joint venture partners. They considered that financial sector reforms should focus on removing barriers to the availability of credit to the private sector.